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Tuesday, January 6, 2009

A new revision to the FICO scoring formula will soon be rolled out. In fact, two of the three credit bureaus have already admitted to the new rules. In effect the credit balances that you carry will matter more than ever to the scoring, but luckily your little missteps will count less.This update to the credit scoring system (called FICO 08) has been delayed for several months, but it finally will be rolling out early in 2009. It offers a few advantages to the consumers but also includes some serious new risks. The new scoring system is supposed to do a better job of predicting defaults than the classic FICO that we are used to.

Somewhere between 75% and 90% of national lenders use the FICO system to evaluate the credit worthiness of applicants. It is reported that FICO 08 is even more sensitive than the classic FICO to how much of your available credit that you are actually using. If a credit card issuer reduces your credit limit then you could see your credit scores plunge, even if you are not carrying a balance over from month to month.

Also the new formula responds more negatively if your number of open accounts falls, as is the case currently when the card issuers are closing or deactivating accounts that are not used much (those accounts are not very profitable, but still offering risks to the card companies). Your FICO 08 scores can go down with just this reduction of open/available credit.

On the other hand, many changes to the new system are not bad . FICO 08 does provide some improvements, including:

Collections – The new formula does ignore some of the small collections (garbage) that can occur if the original debt is less than $100.00. This is a way overdue improvement.

Credit missteps– The new formula is less punishing to people who have had a repossession or account charge-off as long as the more recent activity is problem free.

Authorized users – The new formula will be factoring in some limited number of authorized user accounts (used by some to improve their own account scores), but supposedly ignore additional ones if they materially affect the score.

Installment loans – The new formula is even more sensitive to the mix of revolving credit (cards, etc) and installment loans (homes, cars). Preference is given to the installment type loans over the revolving type loans and the scores will reflect this preference.

Credit inquiries – This is still a confusing issue, with many experts on both sides. Some believe the new formula will allow more inquiries without punishing the score, while others say this is not true. The best path is still to be very conservative on who and how often your credit is searched